Investors’ Comment Letters Back Pay-Ratio Disclosure Rule

The SEC wants to finalize a rule by the end of the year that will make companies provide the ratio of the CEO’s total pay to that of a median employee.Business groups complain that the rules will impose heavy costs and provide no benefits.Investors say the information is material to their investment decisions at a time when social and governance issues are taking on more prominence.Moreover, they say the rule’s costs will in all likelihood turn out to be much less than what businesses have said.

Investor advocates emphasize the importance they attach to an SEC proposal that calls upon companies to provide the ratio of the CEO’s compensation to the median employee paycheck.

Trillium Asset Management LLC, an investment firm in Boston wrote to the SEC in a July 31, 2014, comment letter that environmental, social, and governance factors play an integral role in the firm’s investment decisions.In Trillium’s view, companies with good performance on governance pose less risk and offer higher returns to shareholders.

High pay disparities “can hurt employee morale and productivity and have a negative impact on a company’s overall performance,” wrote Brianna Murphy, Trillium’s vice president for shareholder advocacy.

The SEC in September 2013 issued the proposal in Release No. 33-9452,Pay Ratio Disclosure,to satisfy a requirement from the Dodd-Frank Act.The comment deadline was in December, but investors and business groups have continued to submit letters.

The market regulator is expected to finalize the rule by the end of 2014.

Companies view the proposed requirement as highly controversial.Many began challenging it before it was issued.In response to complaints about the difficulty of calculating the ratio, the SEC is allowing companies some flexibility in producing the data. The proposal doesn’t specify a single method for calculating the median, but public companies can choose a process that fits their structure and compensation programs.For example, the proposed rule lets a large company use a statistically representative sample of its workforce rather than the entire population.

Companies also won’t have to calculate the exact compensation when identifying the median.Instead, a company could apply any “consistently used compensation measure,” such as the amounts reported in payroll or tax records.Companies will still have to calculate annual total compensation, but the SEC will let them use “reasonable estimates” when making the calculation.They would be required to disclose the method used to determine the median employee pay, as well as estimates used in calculating the ratio.

The SEC’s suggested alternatives didn’t mollify companies who want a much simpler requirement.The U.S. Chamber of Commerce submitted a May 2014 report that said the rule will impose “egregious costs” on businesses and challenged the need for the rule.

“The intent behind the pay-ratio rule is inherently political as it is designed to ‘shame’ American businesses in order to placate certain special interest constituencies,” the report said, adding that the ratio is flawed and fundamentally misleading because it provides no particular insight whether a CEO or the median employee is fairly compensated.

For example, a retailer will have workers earning hourly wages, while an investment bank will have very few hourly wage workers.The pay ratio for the CEO of the retailer may be much higher than that for the CEO of the investment bank, the U.S. Chamber said.

Moreover, the group complained that SEC’s estimated costs are inaccurate.The SEC said the rule would cost U.S. companies about $72.7 million annually.A Chamber survey of 118 companies produced an estimated yearly cost of $710.9 million.

The Chamber’s findings were challenged by Sue Ravenscroft, an accounting professor at Iowa State University, who said in a June 18 comment letter that the lobbying organization failed to provide information about how its survey was carried out, including the process for selecting the 118 companies.

Some 25 of the 37 companies that operate in fewer than 10 countries provided a cost estimate.Only 12 of 20 companies that have more than 100 data systems provided a cost estimate.

Ravenscroft, who’s worked as an auditor, acknowledged that there will be some complex challenges for international companies in getting the ratio, but many of the challenges are met regularly and annually during audits.

She also noted over the years that corporations responded to every new disclosure requirement “with alarmist exaggerations about the cost of implementation and even more alarmist catastrophic predictions of the failure of the capitalist system this disclosure will precipitate.Yet, many years later, the U.S. stock market is at high levels, despite burgeoning and more complicated disclosure requirements.”

She also questioned the Chamber’s claim that the purpose of the pay-ratio disclosure is to “shame” companies.

“Do they in fact think there is something shameful about CEO compensation rising so quickly, while workers are laid off and receive lower wages in real terms?” she asked.

According to a June issue brief by the Economic Policy Institute (EPI), the compensation ratio was 20 to 1 in 1965, 122.6 to 1 in 1996 and 383.4 to 1 in 2000.In 2013, it was 295.9.If Facebook Inc. were included, the ratio for 2013 would be 510.7 to 1. The EPI excluded Facebook from its data because it didn’t want one company to have such an outsize effect on the results.

“If the firms and boards have defensible reasons for paying CEOs more in this country than they are paid in other countries, more in this era than they were paid relative to average workers forty years ago, they can explain that,” Ravenscroft said. “If the reasons are good and sound, people will hear them.”

“I hope you will resist the opposition to this rule and continue moving towards implementation,” she wrote. “What appears to bother them most is that people will have more information on which they can make decisions.”